Sunday, November 20, 2011

Sliding Into First: Why Israeli Start-Ups Need to Keep Running

In baseball, players often slide into the base in order to
avoid being tagged out, but almost never slide into first base. The reason no
one ever slides into first is not because it’s illegal, but because it slows
down your momentum if you want the option of running onto the next base. A lot
of Israeli high tech companies unwisely “slide into first,” yearning for safety
and calm after years of uncertainty and hard work, but inadvertently end up
losing the precious momentum necessary for continued growth. With fewer late
stage companies generating the kind of momentum and scale that late stage investors
look for, it is little surprise that Israel has an underdeveloped growth
financing market relative to the US. Maintaining
the growth momentum is how big companies are created, and is arguably one of
the biggest challenges now facing Israeli high-tech.

Straddling both the US and Israeli venture markets it is
clear that later stage Israeli start-ups don’t often share the growth
characteristics of their US counterparts. For a variety of reasons, many
Israeli start-ups tend to become more risk averse as they grow more successful.
Each case is unique, but in general such companies see profitability on the
horizon, cringe at the thought of additional dilution and a larger board, and
balk at the idea of making bold moves so close to reaching safe ground.

In contrast, US start-ups are more likely to see signs of
success and decide to take on additional risk by hiring faster, expanding
abroad, making acquisitions and launching multiple new product lines in
parallel. Many people claim that US start-ups are simply better at fundraising
than Israeli start-ups, but this is mostly because they are also more effective
at spending those funds to generate growth.

PSYCHOANALYSIS

There are multiple factors at work
that cause Israeli companies to “slide into first.” First of all, maintaining the
growth momentum often requires inorganic growth and therefore moving out of our
“comfort zone.” This may include hiring non-Israelis into key executivea
positions, hiring lots of sales staff in far off geographies, developing partnerships
and making acquisitions, each of which can create a sense of losing control.
Product acqusitions in particular are difficult for technology savvy Israeli
companies to pursue due to intense NIH (not invented here). American companies
don’t have the same cross border cultural challenge, have a much larger talent
pool with which to grow, and often see their core competence as busienss rather
than technology (making technology acquisitions more straightforward).

Secondly, investors in Israeli start-ups
are often investing out of smaller fund vehicles, and as a result have a
tendency to shy away from growth plans that require financing far in excess of
what they can provide going forward. Fundraising apprehension of this sort can
be an enormous barrier to growth because momentum requires consistent
investment in development, product and sales, well in advance of knowing
what will be successful ….and in advance of knowing who will fund it. Trying to
raise growth financings after your company’s year over year growth has slowed
to 20% is as good a parachute designed to open on the second bounce.

A final reason we tend to slide instead of accelerating is eagerness
on the part of founders and VCs to “cash in” their investment rather than
“double up” on their investment. It’s not simply that Israeli start-ups sell
early, but that we avoid taking more aggressive and accretive steps earlier on,
which would made rejecting an acquisition offer all the more obvious.

CHANGE IN THE AIR

The Israeli market is changing before our eyes and this is
something to be excited about. This post
comes on the heels of several growth stage financings that have rarely been
seen in Israel before. Israeli start-ups in clean tech, consumer tech, semiconductors,
adtech and consumer Internet have announced financings ranging from $25M-$50M
for businesses that are growing fast and don’t want cash constraints to limit
their potential. Some of these companies could ostensibly survive without
additional equity funding, so these entrepreneurs and board members truly represent
a new mode of thinking big.

One example of the new mode of thinking is the growing acceptance
of founder liquidity. Many of these larger financings involve the sale of a
fraction of the founders’ holdings, and sometimes the holdings of angels and
veteran employees. However difficult it is for some to accept this trend, it is
exactly the kind of move that enables key decision makers in a company to “double
down” in the form of several more years of hard work in order to focus on the
long-term growth.

Not everyone realizes it, but growth equity investors are well
represented in Israel and BVP intends be a major player locally, just as we are
in the US. But while capital availability is necessary, it is far from
sufficient to producing Israeli growth opportunities. That depends on
entrepreneurs and existing shareholders taking a long-term view to company
building that emphasizes calculated risks for growth and not simply patience
and perseverance (which can often be just pigheaded if growth is elusive or
margins poor). Israeli companies need to keep running fast, focusing on how to
reach second and third base well before reaching first. And it’s ok if you over
run first base. Just don’t slide into it.

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The thoughts and opinions expressed herein belong to the author and do not necessarily reflect those of Bessemer Venture Partners or any of its affiliates (“Bessemer”). The material here is written on the author’s own time for [his/her] own reasons and Bessemer has not reviewed or approved the information herein. Any discussion of topics related to Bessemer or its investment activities should not be construed as an official comment of Bessemer.